Why smaller fund managers should not use reverse solicitation

Introduction

Fund sponsors/managers (”Fund Managers”) looking to fundraise for their funds in the European Union have likely heard of the so-called “reverse solicitation”. It has become a popular, yet dangerous, approach for smaller funds looking to navigate the complex regulatory landscape without the need for a marketing passport.

However, relying on reverse solicitation should not be done lightly nor should it ever be the main fundraising tool for a fund.

This article explores the concept of reverse solicitation, discusses why it is commonly used (probably wrongly) by smaller funds, and highlights the enforcement efforts and potential sanctions associated with its misuse.

Key takeaways

• Reverse solicitation is the process where limited partners (”LPs”) proactively contact the Fund Manager to invest in their funds, without any (direct or indirect) marketing effort towards such LPs.
• Emerging Fund Managers may be tempted to use “reverse solicitation” to fundraise with LPs who are not based in the jurisdiction where the fund is incorporated.
• This business model is not sustainable and is extremely risky: from criminal fines to bans to exercising the profession, misusing reverse solicitation can kill your career as an emerging Fund Manager.
• Increased scrutiny in the European Union over the last year(s) on the misuse of reverse solicitation means that it should not be used as a way to circumvent marketing rules.
• There are however compliant and straightforward ways to market smaller funds throughout the EU, and Roundtable can help you with this.

What is reverse solicitation?

Reverse solicitation occurs on rare instances when a potential LP independently approaches a Fund Manager to invest in a fund, without any prior marketing efforts directed at them by the Fund Manager or anyone acting on their behalf. This concept contrasts with marketing, where Fund Managers (or intermediaries) reach out to potential LPs through various channels.

When genuine reverse solicitation occurs, the targeted fund may generally accept the LPs who have reached out to them without the need to register for marketing in the country where the LPs reside.

Over the last years, the concept of reverse solicitation has been further restricted and is interpreted restrictively.

For example, in 2024, the European Securities and Markets Authority (”ESMA”) has issued guidelines on the concept of reverse solicitation. These guidelines, although they have been issued in relation with crypto-assets service providers, should help Fund Managers to assess what qualifies as genuine reverse solicitation. For example:

• Any type of interaction could be seen as a solicitation by the Fund Manager, especially in the context of online advertisement, thereby excluding reverse solicitation.
  • For example, if your Fund is based in Spain but you have a French version of your website, it will be difficult to argue that you are not marketing in France/Belgium.
• Even if it's not the Fund Manager who's soliciting directly, any interaction between the LP and any person acting on behalf of the Fund Manager could exclude the reverse solicitation.

Why emerging Fund Manager might be tempted to rely on reverse solicitation

Many smaller funds face significant challenges in obtaining a marketing passport, which is required to market funds across multiple EU jurisdictions. The process can be costly and time-consuming, posing a barrier for smaller funds with limited resources.

Emerging Fund Managers may thus be tempted to avail of the marketing notification and registration in various EU Member States and to onboard investors under a reverse solicitation mechanism, suggesting that no marketing efforts (even limited) have been done in those Member States, but that LPs residing there have proactively reached out to them.

However, in some instances, reverse solicitation is used under disguise to market a fund without authorisation. In this context, Fund Managers have private discussions with those potential LPs and ask them to sign a reverse solicitation letter (usually, a template letter drafted by the emerging Fund Manager). This approach is strictly illegal and may lead the Fund Manager to face criminal penalties, as further discussed below.

Sanction for misusing reverse solicitation

Marketing a fund under the false disguise of reverse solicitation is a criminal offense that can lead to severe sanctions (several millions euros in fines, prohibition to further act as fund manager, etc).

These sanctions are effectively applied in practice. National regulators have started to take action against “false” reverse solicitation. In France, for example, the AMF fined a distributor that had falsely relied on reverse solicitation to distribute a fund in France.

In this case, it was striking to note that:

• the regulator ruled that there was no reverse solicitation, despite the letters signed by the investors attesting that there had been reverse solicitation (i.e. facts take precedence over form);
• there had been no complaints from the investors (i.e. the increased monitoring is now done proactively);
• both the distributor and its manager (natural person) were fined a significant amount (150.000 euros and 50.000 euros respectively), and the manager was banned for five years to exercise its profession.

Additionally, in several countries, falsely relying on reverse solicitation can also lead to the nullity of the subscription made by the LP. This means that the fund could be liable to reimburse the LP (even if it has lost the money).

Combatting misuse of reverse solicitation : a priority on the agenda of regulators

In recent years, especially since 2022, the ESMA and national regulators have increased their monitoring of reverse solicitation practices. In a letter issued in 2022, the ESMA:

• Highlighted concerns that reverse solicitation is often used to bypass third-country and EU passport rules, potentially harming investor protection and creating unfair competition; and
• Recommended that each fund disclose the extent of reverse solicitation.

National regulators have since intensified their scrutiny of reverse solicitation. For instance, in Italy and Cyprus, Fund Managers must annually report the level of reverse solicitation in their funds.

For emerging Fund Managers relying on reverse solicitation, this increased oversight means they will soon need to self-declare significant volumes of reverse solicitation to their national regulators. This could prompt investigations into the authenticity of these claims and may result in severe penalties if they are found to be false.

Path forward

As is clear, reverse solicitation should never be the distribution business model for emerging Fund Managers. This is not to say that emerging Fund Managers should not market throughout the EU.

In fact, Roundtable EuVECA Manager Lux, a registered EuVECA Manager in Luxembourg, can help you launch and market your venture capital fund compliantly with professional and high net worth individuals throughout the EU.

Conclusion

While reverse solicitation may seem like an attractive shortcut for emerging Fund Managers navigating the complex regulatory landscape of the European Union, it is illegal and carries significant risks.

The recent emphasis by ESMA and national regulators on monitoring and enforcement underscores the dangers of misusing reverse solicitation.

Fund managers should be aware that relying on reverse solicitation as a primary fundraising tool is unsustainable and fraught with potential legal repercussions, including hefty fines, bans from practicing, and the nullification of investor subscriptions.

Reach out to Roundtable if you wish to further discuss this topic and consider launching your fund!

{{blog_banner}}